I’m 55 and would like to retire now with a $3 million total net worth. I’m assuming my net worth will grow, on average, 5% until I’m eligible for Social Security. My house is paid off and my lifestyle is simple. I can live with $5,000 per month. Am I making the right decisions?
– Peter
At first blush, supporting $5,000 in monthly living expenses on $3 million seems like an easy feat. But I like to start by thinking about scenarios like this in terms of your distribution rate – the percentage of your money you’ll be withdrawing each year. Withdrawing $60,000 per year would equate to just a 2% annual withdrawal rate, which is incredibly low by pretty much anyone’s standards. That would put you at very little risk of running out of money.
However, since you say “net worth” instead of nest egg or savings, I would encourage you to take a hard look at how your net worth is composed. Are your assets mostly liquid, like stocks and cash? Or is your net worth primarily tied up in illiquid assets, such as real estate? The answer may dictate how much you can afford to withdraw. (And if you need more help determining when you can retire, consider speaking with a financial advisor.)
Examining Your Net Worth
Your net worth is the value of all of your assets minus any debts. For example, if you own a property that’s worth $500,000 and have a $300,000 mortgage, it contributes $200,000 to your net worth. Of course, your investments, cash and other savings all contribute to your net worth as well.
I mention this because the way your $3 million net worth is spread across different types of assets can affect how capable you are of supporting yourself with it. All assets don’t provide the same level of flexibility.
To illustrate my point, consider this hypothetical scenario: your home, which you own free and clear, has a current market value of $2 million. That means your liquid assets, at most, are worth $1 million. Assuming you don’t want to tap into your home equity, you’d be using your $1 million in liquid assets to cover your living monthly expenses. That means you’d be withdrawing 6% of your portfolio per year, which is considerably higher than the 2% mentioned before, putting you at a heightened risk of running out of money.
If illiquid assets are only a small component of your total net worth, then this isn’t much of an issue. Just make sure you consider this balance when deciding on a distribution rate and developing a retirement income plan. (A financial advisor can help you assess your net worth and build a retirement income plan.)
How Age Can Restrict Your Withdrawals
If you’re relying on distributions from tax-advantaged retirement accounts, pay attention to the early distribution rules. Since you aren’t age 59.5 yet, you’ll be subject to a 10% penalty in most cases.
However, there are notable paths around this rule. If you have an IRA, you can look into substantially equal periodic payments (SEPPs), which allow you to tap into your savings before age 59.5 without incurring the early distribution penalty. Keep in mind that once you start SEPPs, they will continue on an annual basis for five years or until you reach age 59.5. Ending these payments before then will trigger the 10% penalty.
If you have a 401(k), the rule of 55 can help you access your retirement savings early, as well. This rule allows you to make penalty-free withdrawals from your current employer’s 401(k) or 403b plan if you leave that job in the calendar year you turn 55 or later. (And if you’re deciding how to best withdraw your retirement savings, SmartAsset’s free tool can help you match with a financial advisor.)
Considering Your Personal Preferences
Your own personal preferences regarding lifestyle, investments and risk tolerance all play a part in this planning too. It’s very important that you don’t overlook this. What may work for someone else, may not work for you.
For instance, if you’re especially risk-averse, it’s possible that you invest too conservatively and your portfolio can’t grow enough to sustain inflation-adjusted withdrawals. You’ll also want to ensure you’ve accounted for inflation in your growth estimate.
On the other hand, if you’re a very aggressive investor (although it doesn’t sound like you are) and invest too heavily in stocks, you may be overexposed to the sequence of return risk which could also derail you.
Again, I’m using extremes. There’s a wide range in between these points that works just fine. I’m simply illustrating the point that you should consider how your personal attitudes about various facets of your financial plan should influence your decision. (A financial advisor can help you account for your lifestyle and other personal preferences when planning for retirement.)
Bottom Line
Most people will be perfectly capable of supporting a $5,000 monthly retirement budget on $3 million, as long as it’s adequately liquid and properly diversified. However, the math is never the full story. Make sure to consider how personal factors like your risk tolerance and lifestyle expectations could impact your financial plan in retirement.
Tips for Finding a Financial Advisor
Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Brandon Renfro, CFP®, is a SmartAsset financial planning columnist and answers reader questions on personal finance and tax topics. Got a question you’d like answered? Email AskAnAdvisor@smartasset.com and your question may be answered in a future column.
Please note that Brandon is not a participant in the SmartAdvisor Match platform, and he has been compensated for this article.
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